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The ownership of more than half of UK-quoted shares by rest-of-the-world owners raises questions for corporate governance and the ‘comply or explain’ regime, says Robert Bruce

This article was first published in the November/December 2013 UK edition of Accounting and Business magazine.

One of the great successes of the past couple of decades has been the acceptance of corporate governance into the mainstream of business life. It is hard to recall a world which didn’t have audit committees and didn’t aspire to non-executive directors worth their salt.

But it was not really that long ago. Last year, for example, saw celebrations of the 20th anniversary of the Cadbury Code, the system, as the Code said at the time, ‘by which companies are directed and controlled’. And the central tenet of that system is that of ‘comply or explain’, a means whereby companies are not strait-jacketed by rules but are able to bypass them if it can be argued that they make no sense in particular circumstances. It is a system that has enabled a civilised process. It is not the exponentially expanding world of thousands upon thousands of pages of Sarbanes-Oxley and Dodd-Frank rulebooks in the US, for example. Instead it is based on largely accepted principles which are policed by effective regulators but where peer pressure and the danger of reputational damage play a strong, if not dominant, part.

But much of this depends on a largely homogenous world of companies and investors. In early autumn in the UK a set of statistics was issued which suggested that many of the market assumptions underlying the current corporate governance system could now be flawed. The figures came from the UK’s Office for National Statistics, (ONS), and dealt with the ownership of UK quoted shares. In a nutshell, they showed the continuation of what appears to be an inexorable trend. The key figure is that the ownership by rest-of-the-world investors of shares by value on the UK stock market is now well over half that market. Back in 1998 the figure for rest-of-the-world investors was 30.7%. By 2010 the figure had reached 43.4%. And the new figure, for the end of 2012, was 53.2%.

This has serious implications for a ‘comply or explain’ regime, for example, which really only covers the UK. And the nature of the other owners of shares in the UK market also causes corporate governance concerns. ‘The trend is clear,’ says Paul Moxey, head of corporate governance and risk management at ACCA. ‘It is much more internationalised. Back in the days when the Cadbury Committee was producing its Code, UK insurers and pension providers owned around half of the market. Now it is a very small percentage.’

The ONS figures show that pension funds now own a mere 4.7%; insurance companies 6.2%; and individuals 10.7%, a slight rise to buck the last few years’ downward trend. The statistics tend to be taken with a bit of a pinch of salt. ‘Ownership figures should be used with some caution,’ says Guy Jubb, global head of governance and stewardship at Standard Life Investments. ‘Nevertheless it is clear there is a growing and well-established trend to global investment mandates. That means there is not only a greater diversification of risk but also a dilution of domestic stewardship.’

And around the world stewardship is the worrying factor. A lack of common governance guidelines brings confusion. Back in September the Chinese trading giant, Alibaba, found the Hong Kong stock exchange refusing to agree to its IPO because the company was insisting on a structure where a partnership, rather than the new shareholders, would nominate most of the board. Sovereign wealth funds, some of the largest investment mechanisms in the world, also have a varied record.

A recent audit showed that none of the 26 funds which signed up to a series of principles around basic good governance and financial reporting in 2008 are yet fully compliant. On the other hand the world’s biggest sovereign wealth fund, that of Norway, set up a separate board in August this year to advise it specifically on corporate governance. One of the appointees is John Kay, prominent in the UK for the report on long-term investing.

It is a mixed message but the truth is that many overseas investors do not want to get involved in stewardship. ‘There are consequences,’ says Jubb, ‘particularly for the very largest companies with very global share registers, that they become accountable to everybody but accountable to no one.’ Paul Moxey agrees. ‘The stewardship code really just touches the surface of the issue. The trend is one way and makes organisations less and less accountable.’

This was not what the Cadbury Committee had in mind when it was formulating its Code. A new book* provides an account of the work that went into creating what has become the benchmark of corporate governance. ‘Since 1992,’ say the authors, Laura Spira and Judi Slinn, ‘the principles first articulated by the [Cadbury] Committee have become widely accepted and have formed the basis for corporate governance developments around the world.’ And the difference has been immense. Jonathan Hayward, director and co-founder of consultancy firm Independent Audit, points out that: ‘The fact is that “comply or explain” has made a difference. And I see boards do care. I don’t see boards making a calculation that the majority of their investors may not mind about this.’

But the truth is that growing internationalisation may be sidelining the corporate governance trend. As a forthcoming report from ACCA will suggest, businesses have become more complex and now exert a greater global impact on societies. But, as Spira and Slinn show, the essence of Cadbury, the use of an easily comprehended set of principles followed up by peer pressure and a desire to protect a reputation, is the most effective method of bringing companies to heel.

The time is probably right to start trying to establish globally accepted principles. ‘In response to the changing conditions,’ suggests Standard Life’s Jubb, ‘we could see the evolution of global stock indices comprising companies which meet specified global governance standards. These could assist investors in assessing and understanding the governance risk profile of their portfolios.’

Much was made in the Cadbury process of the persuasive effect of evolution rather than revolution. It is no doubt time for a bit of an evolutionary jump in global corporate behaviours.

Robert Bruce is an accountancy commentator and journalist

Last updated: 5 Nov 2013